OTC Derivatives Reform: Part 3

BNY Mellon experts and the University of Cambridge Judge Business School did a deep dive on over-the-counter (OTC) reforms and their impact on Sovereign Wealth Funds (SWFs).

Recommendations for a Changing World

Regulatory changes to the OTC derivatives market require SWFs and other asset owners to reconsider their existing approaches to how they trade and clear these instruments. But, as highlighted [in Section 3 of the full report], the OTC derivatives markets reforms are part of a wider, interconnected picture. While many of these other post-crisis reforms only impact SWFs indirectly, in total they represent a reshaping of the financial markets which presents significant challenges and opportunities to all asset owners.

As such, this section summarises the key considerations when choosing a future clearing model, and also offers some further suggestions for how the investment strategies and operations of SWF and other asset owners may evolve for optimal returns in an ever-changing world.

Recommendations

Our research does not make specific recommendations, because the optimal clearing model depends on the characteristics of each asset owner. Moreover, some potential changes in OTC derivative regulations remain uncertain. As such, below we offer a framework to help determine the optimal clearing model:

Alternative 1: Switching to Central Clearing

Alternative 2: Switching to two-way CSA

Alternative 3: Remaining with one-way CSA

A Flexible Approach to a Changing World

Post-crisis financial reforms have had a much larger impact on market structure operators and service providers than on asset owners such as SWFs. But that does not mean large institutional investors should leave their banks and other service providers exclusively to implement and manage the new regulatory requirements. All asset owners will have their own investment priorities and risk appetite, informed by their own set of unique circumstances. However, the scale of change in the financial markets is such that an increasing number of SWFs are already reviewing their policies and procedures in light of emerging opportunities.

Demonstration of Netting Efficiencies

Lays out the cost-benefit analysis of SWFs options for OTC derivative clearing, touching also on broader strategic counterparty implications

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